RISK ALLOCATION IN CONSTRUCTION PROJECTS

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RISK ALLOCATION IN CONSTRUCTION PROJECTS

• Lorman Education Services
• Eileen M. Diepenbrock
• William A. Lichtig
• Jay C. Davison, AIA
• September 2, 2004

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ALLOCATING RISKS OF DESIGN ERRORS
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The Dilemma for the Owner

• Owner Contractor
• Implied warranty of plans
• Responsibility for deficiencies
• Recovery for extra work

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The Dilemma for the Owner

• Owner Designer
• No warranty of plans
• Breach of contract
• Professional negligence

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The Dilemma for the Owner

• Professional Negligence is .. the failure
  to exercise the skill, knowledge, and care
  ordinarily possessed by members of the profession

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The Dilemma for the A-E

• Are design fees adequate to produce high-quality
  documents?

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Pressures on Design Fees

• Fee scales established in industry, often by
  agencies
• Increasing complexity of work
• Increasing number of tasks and specialties
• Increasingly litigious atmosphere in the
  construction industry

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Pressures on Firm Profitability

• Traditionally a low-profit business
• Increasing salary pressure
• Shortage of qualified personnel
• Increasing complexity of work

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Would Increasing Design Fees Result in
Higher-Quality Documents?

• Workload could be calibrated to available
  professional staff
• Outside peer reviews could be initiated (and paid
  for) by A-E
• More budget could be devoted to CA
• Would owners have to compete for qualified
  design firms?

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Completeness of Design Documents

• What is shown/specified?
• What is implied intent?
• What is good enough?

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Communication 1

• Design documents attempt to communicate the
  intent of the designer
• Bids represent the contractors understanding of
  that intent
• RFIs represent confusion
• Change orders represent misunderstanding

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Communication 2

• Has the quality of designers communication
  changed?
• Do different contractors understand and respond
  at different levels?
• How might this communication be improved?

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Trends in Document Preparation

• Show/specify an item only once
• Do not over-detail
• Reduce required submittals
• Use alternative media (e.g. photos)
• Transfer design responsibility where possible to
  do so

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Areas With High Potential for Problems to Arise

• Or equals and substitutions
• Changing trade standards
• Proprietary specifications
• Complete and operating system

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Constructability Reviews as a Means of Improving
the Quality of Construction Documents
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What Means Constructability Review?

• Coordination, conflict, completeness (Quality
  Control)
• Code compliance
• Program compliance
• Standards compliance
• Constructability
• Value engineering

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Quality Control Review

• When documents 95 complete to avoid
  duplication of efforts
• By whom another design professional (peer)
• Why improve quality of documents to reduce
  potential misunderstanding

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Code Compliance Review

• When early in design development
• By whom another design professional or an
  individual trained in code enforcement, e.g.
  licensed inspector
• Why avoid having to modify documents at the
  last minute to comply

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Program Compliance Review

• When at the end of design development
• By whom the person who developed the program
• Why to ensure that the owner is getting all the
  items they asked for

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Standards Compliance

• When After specifications are well developed
  (usually in CD phase)
• By whom the author of the standards or the
  departments that helped develop them
• Why to ensure that the designer is specifying
  the materials and systems the owner wants

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Constructability Review

• When CD phase, after specifications are
  reasonably well developed
• By whom a contractor or other construction
  professional with actual hands-on experience
• Why to uncover details that might be difficult
  or costly to build, and materials and systems
  that are proprietary, or difficult to procure.

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Value Engineering

• When early and throughout design
• By whom a certified value engineering
  professional
• Why to save cost without comprising quality or
  design intent

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Important Issues

• Cost vs. benefit
• Backcheck did review items get addressed?
• Is this an additional service to the designer?
• Who assumes design liability?
• Potential bid delays

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Owner Liability Issue

• If a review identifies potential problems in the
  documents and appropriate corrections are not
  made, is the owners liability increased?

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Shifting the Risk of Design Errors to the
Contractor
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Pre-Bid Review of Construction Documents

• Owners warranty of plans
• Contractors obligation to review
• How to allocate the risk

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Pre-Bid Review

• Time
• Design
• Bidding
• Information Available
• Owner-furnished
• Publicly available
• Contractor-generated
• Contract Requirements

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Level of Review

• Reasonable review given thepurpose of pre-bid
  review
• Patent or Obvious
• Not required to second guess owner/designer

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Coordination and Lay-Out Drawings

• What are they
• When
• Who prepares
• Purpose

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Striking a Balance

• Designers must accommodate identified systems
• Contractors must coordinate identified systems

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Resolving Conflicts

• Not enough space
• Routing conflicts with structuralcomponents
• Components conflict with each other
• Design deficiency?
• Coordination error?

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Composite Drawing of Typical Lab
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Corrected Composite Drawing of Typical Lab
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Field Verification

• What is required
• When
• Examples
• Existing construction
• New construction

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Financial Responsibility

• No additional compensation
• Affirmative liability to owner
• Level of knowledge
• Contract allocation

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Who Should Bear the Risks?
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EVERY PROJECT COSTS A CERTAIN AMOUNT

• Costs of Design
• Costs of Construction
• Costs of Risks

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How Can the Risks be Mitigated?

• Owner Keeps the Risks and Tries to Get the Best
  A/E and Contractor
• Owner Gives the Risks to the A/E
• Owner Shifts the Risks as Much as Possible to the
  Contractor

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HOW CAN THE PARTIES WORK TOGETHER TO COLLECTIVELY
REDUCE THE RISK?
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ALLOCATING RISKS OF UNEXPECTED SITE CONDITIONS
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TYPE I DIFFERING SITE CONDITION

• Site Condition Which Differs Materially From That
  Indicated in Contract Documents
• Contract Documents Indicate Type of Conditions to
  be Expected
• Representation Must Differ Materially from Actual
  Conditions Encountered
• Contractor Must Have Reasonably Relied on
  Contract Representations to its Detriment

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TYPE II DIFFERING SITE CONDITION

• Unknown Site Condition Which Differs Materially
  From That Reasonably Expected as Inherent in the
  Nature of the Work to be Performed
• Examine Contract Documents Closely for
  Disclaimers and Definition of Contract
  Documents
• Are site investigation studies provided for
  information only?

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TYPE II DIFFERING SITE CONDITION

• Heavy Burden of Proof
• What was actually known about the site
• Why condition encountered was unusual
• The DSC is materially different from what is
  considered ordinary

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THE DIFFERING SITE CONDITION CLAUSE

• RISK ON OWNER
• Lower Bids
• Equitable Adjustment
• No Restrictions

• RISK ON CONTRACTOR
• Higher Bids
• May Not Be Allowed On Public Projects

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SHIFTING RISK DISCLAIMERS

• Disclaiming Geotechnical Information From the
  Contract
• Disclaiming the Accuracy of Plans and
  Specifications
• Disclaiming Inferences Drawn From Existing
  Conditions
• Combination of all

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DISCLAIMING GEOTECHNICAL INFORMATION FROM
CONTRACT

• Intent is to Prevent Type I Claim
• Disclaimer is Frequently Enforced
• Examine Disclaimer Carefully
• General Disclaimer is Insufficient
• Disclaimer Must Caution Against Reliance on Data

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DISCLAIMING WARRANTY OF ACCURACY

• May be Restricted by the Spearin Doctrine
• May be Restricted by Positive Misstatement of
  Conditions
• May be Restricted by Statutes (Public Projects)

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DISCLAIMING WARRANTY OF ACCURACY

• Enforceable if Makes Reliance on Data
  Unreasonable
• Effective to Disclaim Contractors Subjective
  Interpretation of Data

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DISCLAIMING INFERENCES FROM SITE INFORMATION

• Effective to Shift Risk of Conclusions from Data
• Limits Implied Warranty of Data
• Assumes Accuracy of the Date Itself

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SHIFTING RISK SITE INSPECTION CLAUSES

• No Apparent Restrictions
• Enforceable to Waive Conditions Reasonably
  Discoverable
• Failure to Comply can Cause Loss of Claim

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SITE INSPECTION CLAUSES

• Apparent Conflict with Differing Site Condition
  Clause
• Reasonableness Standard Contractor is obligated
  to discover those conditions apparent through a
  reasonable investigation
• Does not Excuse Material Misrepresentation

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REASONS FOR DENIAL OF CLAIM

• Failure to prove differing site condition
• Failure to follow contract procedures regarding
  differing site conditions
• Failure to comply with site investigation clause
• Failure to consider effects of weather
• Failure to document and prove damages due to
  claimed differing site condition

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ALLOCATING RISKS OF CONSTRUCTION ERRORS AND DELAYS
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Role of the Architect
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Role of the Architect

• Inspection vs. Review
• Submittals
• Substitutions and or equals
• Conflicts in the documents
• Authority to make changes

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Role of the Architect Inspection vs. Review

• Insurance implications
• Liability for safety
• Projects where inspection is required (e.g.
  schools, hospitals)
• Level of site visits fee will support

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Role of the Architect Submittals

• Timeliness of submittal and speed of review
• Purpose of submittals
• Insurance implications
• Legal effect of review
• Incomplete submittals
• Schedule implications of rejection

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Role of the Architect Substitutions and or
equals

• What is the difference?
• Substitutions masquerading as equals
• Why accept substitutions?
• Collateral risks of substitutions
• Who pays for review of substitutions?

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Role of the Architect Conflicts in the Documents

• Errors vs. Omissions
• Common types of errors
• Order of precedence clauses
• How conflicts are addressed
• Costs of errors and omissions
• Third party (e.g. CM) involvement

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Role of the Contractor
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Means and Methods

• How project will be built
• Sequence
• Schedule
• Crew size
• Techniques
• Equipment

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Risk to Owner

• Specifying means and methods
• Not allowing contractor to use selected MM
• Examples
• Excavation equipment
• Sequencing

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Risks to Contractor

• Selected MM will be properly rejected
• Example Thin brick
• Selected MM will not work
• Selected MM will be costly

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Following/Interpreting the Contract Documents

• Evolution of pre-bid obligations
• Contract clauses seek to shift risk to
  contractor
• I dont care if its not shown, you should have
  known it was there.

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Contractors Obligation

• Premise All contract documentswill contain
  errors and omissions
• Contractor typically responsible for
• Known EO
• Should have known EO

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Evaluating Responsibility Omitted Work

• Contract structure
• Necessity of work
• Ability to price when bidding
• Obviousness of omission
• Scope
• Price

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Evaluating Responsibility Errors

• Contract structure
• Magnitude of error
• Contractors experience
• Efforts undertaken to evaluate plans
• If discovered, when
• Ability to discover earlier

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Effect of Inspections

• Purpose
• Effect
• Contract clauses
• Practicality

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Effect of Payment

• Contract provisions
• Effect

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Role of the Owner
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Role of the Owner

• Owners responsibility for delay depends upon
• The facts
• The effect on the critical path

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Role of the Owner

• Delay in delivery of materials
• Owner-furnished materials
• Owner-specified materials

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Role of the Owner

• Owner-initiated changes
• Effect on critical path
• Excessive number of changes

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Role of the Owner

• Response time to questions
• Specify in contracts
• Failure to respond shifts risk

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Role of the Owner

• Payment
• 30 days generally
• Late payments bad for everyone
• Contractor deprived of revenue
• Owner at risk

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Role of the Owner

• Coordination of multiple primes is for
  sophisticated and risk-tolerant owners only!
• Management of consultants supervision is
  required

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Alternative Delivery Methods
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Agency Construction Management
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Agency Construction Management
Owner
CM firm
Architect
Contractor
Engineers
Subcontractors
Contractual
Communication
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Agency CM

• CM can oversee scheduling, cost control,
  constructibility review, pre-construction
  management, bidding, construction project
  management

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Agency CM

• Who can provide CM services
• On private sector, can be, but do not have to be,
  performed by licensed contractors, civil
  engineers and architects as long as not acting as
  licensed contractor, engineer or architect
• On public sector, must be performed under the
  direction and control of a licensed architect,
  registered professional engineer or licensed
  general contractor

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Role of the Construction Manager

• Distributing information
• Interpreting contract documents
• Identifying problems and ensuring timely
  resolution
• Assigning responsibility for problems and
  consequent liability for the owner
• Authority to make changes and responsibility for
  changes
• Exposure to liquidated damages

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Agency Construction Management Pros and Cons

• Pro works well for large, complex projects
  requiring significant oversight and coordination
• Pro useful when owner is not sophisticated about
  construction
• Con adds level of coordination, potential
  increased time and paperwork

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CM at Risk
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CM at Risk
Owner
CM firm
Architect
Contractor
Engineers
Subcontractors
Contractual
Communication
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CM at Risk
Owner
CM firm
Trade Contractor
Trade Contractor
Trade Contractor
Trade Contractor
Trade Contractor
Trade Contractor
Trade Contractor
Trade contractor
Architect
Trade Contractor
Trade Contractor
Engineers
Trade Contractor
Trade Contractor
Trade Contractor
Trade Contractor
Trade Contractor
Contractual
Trade contractor
Communication
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Design-Build Contracting
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Design-build
Owner
Design-builder
Architect
Contractor
Engineers
Subcontractors
Contractual
Communication
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Design-Build Contracting

• Use of a single entity to both design and
  construct
• Cost-effectiveness
• Design cost savings
• Avoid the owners dilemma of being caught between
  design and construction teams
• Potentially better overall price

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Design-Build Contracting Legal Issues

• License issues
• Warranty issues
• Public sector issues

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Design-Build Contracting License Issues

• Design-builder must have contractors license and
  design-professionals license or registration, or
  have properly licensed or registered design
  professional in charge of design
• Contractors can subcontract design to design
  professional
• Joint ventures check assets and insurance

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Design-Build Contracting Warranty Issues

• Potentially negates owners implied warranty of
  plans and specs
• Owners warranties typically disclaimed by
  contract
• Contractors participation in design can give
  rise to implied warranties to owner

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Design-Build Contracting Public Sector Issues

• Competitive bidding requirements
• Subcontractor listing laws
• Risk of differing site conditions likely still is
  on the owner Public Contract Code 7104

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Best Value Procurements
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Best Value Procurements

• Goal and process
• Process involves competition, negotiation and
  evaluation of factors beyond price
• Beneficial for complex and infrastructure
  projects
• More widely used on federal projects than state

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Lease-Leaseback
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Lean Construction
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Lean Construction

• Background
• Taichi Ohno (Toyota)
• The dilemma
• The inspiration
• The outcome

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Lean Construction

• Toyota Production System
• Highly specify content
• Yes-No direct connections for requests and
  responses
• Pathways are simple and direct
• Pursue perfection, under guidance of teacher

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Lean Construction

• James Womack Lean Thinking
• Define value from the customers view
• Identify the value stream
• Make the value creating steps flow
• Downstream process pull from upstream
• Continually strive towards perfection

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Five Big Ideas
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Lean Construction

• Last Planner System

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Questions / Comments
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The End
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Role of the Construction Manager Distributing
Information

• Hub of the Wheel
• Handling of various documents, e.g. submittals
  and RFIsvalue added?
• Tracking of speed of response by all parties
• Early warning of cost issues

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Role of the Construction Manager Interpreting
Contract Documents

• Authority
• Responding to RFIs
• Assigning responsibility for problems
• Design Liability

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Role of the Construction Manager Identifying
Problems

• Authority
• Methods of resolution
• Liability for outcome

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Role of the Construction Manager Assigning
Responsibility

• Authority (agency)
• Financial legal implications
• Liability for outcome

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Role of the Construction Manager Authority to
Make Changes

• Authority (agency)
• Financial legal implications
• Liability for outcome

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Role of the Construction Manager Exposure to
Liquidated Damages

• Responsibility authority for schedule
• Effect on relationship actions